Pedro Perez—Former President, Tabacalera

With annual sales of nearly $7 billion (mainly cigarettes), Spain's
tobacco company, Tabacalera, is one of the largest companies in the
international premium cigar market.

Involved with the Cuban tobacco trade for almost four centuries,
Tabacalera is the largest buyer and distributor of Cuban cigars in the
world, purchasing nearly 50 percent of Cuba's annual export of
handmade cigars. The firm is also the largest purchaser of Cuban bulk
tobacco, which goes into machine-made cigars and cigarettes
manufactured in Spain and the Canary Islands. In total, the company
produces nearly 450 million handmade and machine-made cigars.

Pedro Perez, 45, has been the president of Tabacalera since September
1993. He was instrumental in initiating negotiations with General
Cigar, a division of the U.S.-based Culbro Corp., for a 51 percent
stake in the company at a price of about $100 million. [Three days
after this interview, the deal fell through.] Prior to his position
with Tabacalera, Perez served in the Spanish government as the
secretary of state for the economy; undersecretary for planning and
economy, and commerce; and as executive director for the International
Monetary Fund. Marvin R. Shanken, editor and publisher of Cigar
Aficionado, interviewed Perez in Havana in late September.

CA: Can you give us a brief description of Tabacalera--how big it is
and what industries it operates?

Perez: Tabacalera is a holding company with two major parts, the
tobacco business and the nontobacco business. Within the tobacco
business, we have a Tabacalera group that covers both cigarette and
cigar production. As Tabacalera, we produce two and a half billion
packs of cigarettes a year and roughly 350 million cigars.

In addition to Tabacalera, we have subsidiaries, normally 50/50
partnerships. For instance, we have subsidiaries with BAT
[British-American Tobacco], Reynolds, and private investors in the
Canary Islands. With the subsidiaries we produce a total of roughly 4
billion packs per year. That's roughly 80 billion cigarettes, since
the industry standard is 20 per pack.

CA: What are the major brands of cigarettes?

Perez: Our major brand is Ducados. This is the second largest brand in
Europe. We produce 1.2 to 1.3 billion packs. The second of our brands
is Fortuna. We produce roughly 1 billion packs of Fortuna. These are
the two leading brands. In total, we cover almost 95 percent of the
cigarette demand in Spain. We are exporting to France. We are
manufacturing in Poland and we are exporting also to Russia and some
other former republics of the Soviet Union. We also export some small
quantities to other European countries. One of our projects at present
is to expand our presence in the European market.

CA: Which other areas of the tobacco business are you in?

Perez: We are presently in all phases of the tobacco business,
including tobacco leaf and tobacco processing through our two
subsidiaries, CETARSA and INTABEX Holding Worldwide. For cigars, we
make mechanized cigars through Tabacalera and both mechanized and
handmade Canary Island cigars through CITA. The brands include Condal,
La Fama, Goya, Peñamil and others.

In the nontobacco sector, we have a company in the dairy business, the
leading company in Spain, La Lactaria Espanola. We have a stake in an
oil company, Koipe, which is the first olive oil company in the world,
[and] a stake in sugar, Ebro Agricolas. We also have a small company
in the financial sector, covering pension funds.

Altogether, the Tabacalera group consists of more than 20 companies.

CA: What were the annual sales and profits of Tabacalera in 1994?

Perez: Sales of the group was roughly $7 billion. And profit was
around $150 million.

CA: Could you explain the ownership structure of the company?

Perez: Tabacalera was always a company in which the public
[government] sector had a majority stake, 52 percent, [with] 48
percent for the private sector. This situation is not a new one. From
the very beginning, the company was designed as a monopoly rented to
the private sector.

CA: Didn't the government once own the entire operation?

Perez: When Tabacalera began in 1636, the government rented the
tobacco monopoly to the private sector; so the private sector always
managed the company. More recently, after the Civil War in Spain
[1936-1939], there was a change and the public sector took a majority
stake in the company. Since then, the structure has been 52 percent
controlled by the government. Of the remaining 48 percent, 38 percent
is controlled by foreign investors, 10 percent by Spanish investors.

CA: Of the $7 billion in sales, what percentage does tobacco
represent?

Perez: It represents 80 percent.

CA: So that's roughly $5 1/2 billion. Of the $5 1/2 billion, what
portion of that is cigar related?

Perez: Our cigar business is around $300 million annually.

CA: In the cigar world, that makes you one of the largest players?

Perez: Yes.

CA: Could you describe your cigar business?

Perez: As I mentioned, we produce the full range of cigars, from
handmade to machine-made cigars, both in Spain and the Canary
Islands. The main characteristic of our production, both in the
handmade and the machine-made, is the percentage of Havana tobacco in
our blends.

CA: You buy a lot of bulk tobacco from Cuba?

Perez: Yes, we are Cuba's number one client for the tobacco sector, by
far. We buy almost 75 percent to 80 percent of total bulk tobacco
exports from Cuba.

CA: How many cigars do you sell a year?

Perez: We are producing 450 million cigars annually, and we distribute
a total of 660 million cigars.

CA: What percentage of those are handmade versus machine-made?

Perez: Handmade--34 million, 5 million of which are produced by
Tabacalera.

CA: What are your major brands of machine-made cigars and where do
they come from?

Perez: Our leading brand is Farias. Farias represents 60 percent of
the total amount, which means 250 million cigars per year. The blend
contains a very high percentage of Cuban tobacco.

CA: Where is it actually made?

Perez: In the north of Spain. Within the Farias brand, we have the so
called Farias Centenario. The wrapper is Cuban. It's wonderful. It's
the king of the machine-made cigars.

CA: Are all 5 million of your handmade cigars Cuban?

Perez: No. But the blends for them all contain Cuban tobacco. For
instance, the leading brand is Condal. Condal is a handmade Canary
Island cigar. I am tempted to say the percentage of Cuban tobacco, but
this, as you know, is a secret. Condal, also, Peñamil. By the
way, the Peñamil produced in the Canary Islands is quite
different to the Peñamil produced in the United States by
Swisher. The two cigars have nothing to do with each other because of
their different blends.

CA: So the 5 million handmade cigars are all from the Canary Islands?

Perez: Yes.

CA: Are you not also the largest buyer of handmade cigars produced in
Cuba?

Perez: Yes.

CA: Are all the cigars for consumption in Spain?

Perez: Yes.

CA: It's very interesting. You produce your own cigars, using bulk
Cuban tobacco in the Canary Islands, but you also supply the largest
market in the world for Cuban cigars. I was told a few years ago that
roughly 50 percent of the exports of all Cuban cigars go to
Tabacalera, and mixed into that is a sizable amount of machine-made
cigars. Last year, I understand that Cuba exported something like 55
million cigars of which 10 million were machine-made and 45 million
were handmade. Those are the rough numbers I recall. So you bought 27
million?

Perez: Last year, we bought 27 million cigars, most of them handmade.

CA: That figure does not include any machine-made?

Perez: The Cuban machine-made cigars represent a very small percentage
of our purchase.

CA: So what you're saying is that your share of the exported Cuban
handmade cigars is more than 50 percent. If you're saying you
purchased 27 million handmade cigars and the Cubans told me they
exported a total of 55 million less about 10 million machine-made for
a total of 45 million handmade, then Tabacalera represents roughly 60
percent of Cuba's handmade cigar exports?

Perez: Yes, but last year was a very particular year because of the
shortages of tobacco.

CA: At its peak in the late 1970s and early '80s, when Cuba was
exporting 90 to 100 million cigars, what was the highest quantity that
you ever purchased?

Perez: In the past? In the Seventies? We bought about 52 million Cuban
cigars.

CA: Of the 52 million cigars, how many were machine-made?

Perez: A very small percentage.

CA: There is a worldwide shortage of Cuban cigars, and most smokers of
Cuban cigars will take anything they can get. What is it about your
relationship with Cuba that has allowed Spain to be such a dominant
partner?

Perez: We should start by saying that we, Tabacalera, invented the
cigar. It was in our Seville factory that the cigar as we know it
today was invented. It was there that the idea of the filler, binder,
and wrapper was invented. The idea was then exported to Cuba.

CA: So Spaniards moved to Cuba and built the cigar factories?

Perez: Yes, they were Spaniards.

CA: I see. The cigar originated in Spain, but then production
gravitated to Cuba where the tobacco was grown?

Perez: Right. This means that we always have been the first tobacco,
leaf and cigar market for Cuba. It's been like that forever. It means
also that for Cuba, we are their largest market. By far. As I
mentioned, in rough terms, we buy 40 percent to 50 percent of the
total cigar production and 75 percent of the total leaf production for
export.

CA: How big are leaf exports?

Perez: In value terms, it's more or less equivalent to cigars, which
is about $30 to $35 million worth of cigars.

CA: Does that mean that your total purchases of bulk tobacco and
finished cigars equal about $70 million?

Perez: Yes. We buy roughly $70 million [worth] per year.

CA: Can I assume that Spain is also the largest overall trading
partner for Cuba?

Perez: Yes.

CA: Given the long-standing ties between Spain and Cuba, was the
relationship altered during the period when the Soviet Union was a
major financial partner with Cuba?

Perez: Not at all. Perhaps just to stress how profound the roots are
between the two countries, you can examine the time of Franco's
dictatorship in Spain [while] Fidel Castro was in power in Cuba. So,
politically the two countries were complete opposites, but regardless,
Spain was always the first western country trading with Cuba.

CA: In terms of the 27 million cigars which you import and distribute
in Spain, what are the brands and sizes?

Perez: The structure more or less is the following: 50 percent of
total consumption is Montecristo. Within Montecristo, half the demand
is the No. 4 (petit corona). But, for instance, the No. 2
(torpedo) is also very appreciated. The second brand is Fonseca and
the third is Partagas.

CA: Wait a minute. You're saying that of the 27 million, roughly 12 to
14 million is Montecristo and of that, 7 million is No. 4. And what
would No. 2 be?

Perez: No. 2. Half a million.

CA: Is No. 2 your second largest size?

Perez: No, no. After No. 4 is No. 3 (corona), and after that, No. 2.

CA: So No. 2 is over half a million cigars?

Perez: Yes. And the third largest brand is Partagas. Within Partagas,
8-9-8 is the most appreciated.

CA: What would be the size of Partagas annual sales overall?

Perez: About 3 million, I would say.

CA: Three million is Partagas and you're saying the largest size in
that brand is the 8-9-8. You are describing extremely good cigars. Is
that a sign of the sophistication of the Spanish market?

Perez: The Spanish are very educated Havana cigar smokers.

CA: Why is Spain's reputation otherwise? What we hear is that
Spaniards want the cheap cigars, little cigars, and don't appreciate
finer, high-qualiity cigars. But what you're saying is that they are
very sophisticated.

Perez: Yes. For example, we received 500 boxes of Lusitania in
May. They were sold out in less than a week.

CA: Why are prices in Spain also apparently very good?

Perez: We have the lowest prices for Havana cigars because we have the
lowest taxes in Europe on tobacco products. We also have the narrowest
margins, both with retailers and the wholesalers.

CA: Is there very little difference in price at duty-free
versus cigar shops in Spain? Is it fair to say that the duty-free
might be five or 10 percent cheaper, or is it basically the same
price, more or less?

Perez: That's the situation, in general terms, but in some cases
prices in duty-free are more expensive than in Spain.

CA: From your observations, are duty-free cigars any different in
quality than Cuban cigars sold by Tabacalera?

Perez: No, no.

CA: Has there ever been cases where one is getting preferential
treatment?

Perez: No. I am sure that the boxes are the same, the same
quality. Perhaps for some consumers, it's more agreeable to buy at the
dutyfree because the shops may be nicer, but that is it.

CA: Does Tabacalera own any retail shops?

Perez: Just one in Madrid.

CA: Do you ship cigars to customers outside Spain?

Perez: They have to come to Spain.

CA: Is there any evidence that you get a better or lesser quality
Cuban cigar in Spain than in England, France, Italy, Switzerland or
Canada?

Perez: The only difference is that perhaps the British or Swiss market
is more sophisticated in the sense that they demand more premium
cigars, while in Spain we are covering the full range.

CA: Of these 27 million cigars that you distribute in Spain, what
percentage are bought by Spaniards versus tourists?

Perez: The majority is purchased by Spanish people.

CA: Can you give me a percentage?

Perez: I would guess about 90 percent.

CA: In as much as a large part of our readership are Americans, are
cigars well accepted in restaurants in Spain?

Perez: Every restaurant in Spain allows cigar smoking and any decent
restaurant will have cigars to sell.

CA: What percentage of your business is restaurant and hotel versus
retail?

Perez: Normally in our system, restaurants buy from the
retailers. They do not buy directly from us.

CA: But you say, virtually every middle- and upper-market restaurant
is cigar friendly?

Perez: Yes. All. We are a cigar friendly country.

CA: So if we were giving an award to the most cigar friendly country,
perhaps outside of Cuba, we'd have to give it to you.

Perez: Sure.

CA: Could you perhaps discuss what happened three years ago when you
took control of the Montecristo brand, and several others?

Perez: You know that after the Revolution in Cuba, the factories were
intervened by the government, but it...

CA: I like the way you said they were intervened. Confiscated?

Perez: Technically that's right. Cubatabaco was producing and selling
the trademarks of 16 brands. At the time, the value, the appreciation
of the trademarks, was not like now, or 10 years ago. The former brand
owners were aware of the value of the trademark, and they started some
litigation. I think that was in the early '80s.

CA: Which brands were involved in the litigations?

Perez: Montecristo, Partagas, H. Upmann, Por Larrañaga, and La
Gloria Cubana among others. We could see two potential problems with
this. One was for the Cubans. They were using the trademarks without
paying any royalties. Two, the distributors of the brands could also
have a problem with having to pay royalties. This was why Tabacalera
started negotiations with the owners to buy the trademarks. These
negotiations developed in 1987 and ended in 1990.

CA: These were the owners of the trademark outside of the U.S. and
outside of Cuba?

Perez: Correct.

CA: That's the companies of Cifuentes International and Consolidated;
they have a company together called Cuban Cigar Corp.(CCC). So
Tabacalera now owns the trademark for Montecristo and these other
brands all over the world with the exception of Cuba, the Dominican
Republic and the U.S.?

Perez: Yes.

CA: This deal came through in 1991?

Perez: Yes.

CA: How much did it cost you?

Perez: I don't wish to say.

CA: I heard it was something like $10 million?

Perez: (He smiles.)

CA: It would seem to me that this was a bargain--today. Maybe not five
years ago, but today. I mean, don't you think it is probably worth two
or three times that, considering what's happened in the marketplace?

Perez: It depends. I think the price was appropriate, because the
value of a trademark only exists if you have a brand behind that.

CA: So let me ask you this. When Montecristo is sold in Switzerland,
or it's sold in the U.K. or Canada, do you get a royalty?

Perez: No. Our agreement with Cuba is the following: They can use the
trademark as if they were the owner. I mean, they can use the
trademark for the handmade Cuban production without paying any
royalty. In return, they provide us with the best tobacco leaf for our
own productions.

CA: What about the mini-Montecristo?

Perez: Before this problem with trademarks, SEITA [France's tobacco
monopoly] received a license from the Cubans to produce the
mini-Montecristo. That is finished. We are now producing the
mini-Montecristo.

CA: Is that why SEITA is coming out with the mini-Cohiba?

Perez: Yes. In compensation for them losing the mini-Montecristo, Cuba
signed a license for mini-Cohiba with the French.

CA: If the U.S. embargo against Cuba ends, will that alter your brand
ownership agreement with Cuba?

Perez: This is the agreement at this moment. In the future, when the
embargo is lifted, we can enter into a new deal.

[Editor's note: This interview took place on Sept. 23. The following
week, the deal between Tabacalera and General Cigar collapsed after
both sides failed in the final negotiations to agree on issues of
control of the company. Tabacalera refused to change the original
terms which would have given the Spanish company a 51 percent stake in
General Cigar. At the time of the interview, the deal was still on.]

CA: Let's talk about your deal with General Cigar. Did you approach
General Cigar, or did they approach you?

Perez: No, we approached them.

CA: What was it that caused you to be interested in this business
venture?

Perez: As you know, we have a position in the European Union and a lot
of potential in this market. We have a subsidiary, Companias
Philippinas in the Far East. We were missing a third leg to cover or
to be present or to be involved in the three big markets for cigars.

CA: Europe, the Far East and North America.

Perez: Yes. And this is why we were approaching American companies. We
thought at the time that General was the best company for us. It was
the leader in the premium segment.

CA: Did you talk to other companies besides General Cigar?

Perez: This is quite confidential.

CA: Explain to me how you see an association benefiting each party?

Perez: Well. General Cigar is the appropriate complement for
Tabacalera and vice versa. In the sense that, for Tabacalera, General
Cigar can be the company for increasing our presence, and increase the
portfolio of General Cigar with the United States. For instance,
General could introduce our Canary Island cigars, which are, as you
know, wonderful cigars. General has the distribution in the United
States. Macanudo, to begin with, could be introduced in Europe through
Tabacalera. We can give General the muscle for their products in
Europe.

CA: How can the association between Tabacalera and General Cigar
benefit your business in the United States?

Perez: The market in the U.S., thanks in part to your excellent work,
is booming for the first time in many years. Last year was a year of
recovery in the U.S. cigar market. The evolution this year is
confirming this trend and we perceive that this trend can be
maintained in the future. It means that, as you know, the United
States is suffering a shortage of good, handmade cigars. We have the
capacity to supply more handmade cigars and we have a wonderful
product.

CA: You are the largest purchaser of Cuban cigars. The embargo is not
going to last forever. What plans or ideas do you have after the
embargo that will benefit Tabacalera and will benefit General Cigar?

Perez: And also Cuba, of course.

CA: But how will the association help General Cigar? Is this deal in
preparation for the end of the embargo so that the very next day after
the embargo ends, you could be selling Cuban cigars in the United
States?

Perez: It is quite clear that we have a severe shortage of Cuban
cigars. Being the first client of Cuba made it necessary to work with
the country and this is why we designed a resource program where we
give all supplies necessary for the tobacco crop.

CA: For the entire farming operation, or just the portion that relates
to your needs?

Perez: Related to our needs.

CA: That means about 50 percent of the tobacco farms, in the Vuelta
Abajo, for example, would be financed directly by you? Do you get
involved in the farming operations directly such as owning land or
leasing land?

Perez: No, this is the way that it works: In advance of the crop, the
Cubans provide us with a list of needs and the supplies they consider
appropriate every year by item. We then buy the items and we ship them
to Cuba. We assure that every farmer, cooperative and other growing
concerns receive these goods.

Perez: Well, there are a total of about 26,000 hectares [57,000 acres]
of tobacco land in production in Cuba. [Tabacalera supports half of
that acreage.] We also work with the factories.

CA: How much in dollar value does your investment represent?

Perez: Roughly $25 million.

CA: Does that mean it's rolled over?

Perez: Yes. It's a sort of a pre-financing mechanism.

CA: So you put up $25 million, then you buy and they deliver your
cigars; they deduct the $25 million, you pay them the difference. You
are like a bank. And next year, same thing happens. And I assume each
year as their production goes up, your loan goes up?

Perez: Yes, For instance, the plan for this year was, in cigars, 28
million cigars.

CA: Of that 28,500 acres, does that cover just tobacco for cigars or
for bulk tobacco, too?

Perez: Everything.

CA: Everything. What percentage of that would have been for cigars?

Perez: You have to take into account how land is used for tobacco
production. You have a number of acres which have traditionally been
used for growing wrapper.

CA: In dollar value, of the $25 million, how much would go towards
cigars, versus how much would go for leaf?

Perez: I say, more or less half.

CA: This is obviously a critical service that you're providing Cuba
because they're so desperately in need of financial support to be able
to grow tobacco and manufacture cigars. It sounds like a win-win
situation.

Perez: That is the target.

CA: What are you doing to help increase production? Financing existing
production is all right, but to what extent are you involved in their
planning of increasing production so that their exports grow?

Perez: Of the elements we discussed two years ago, we made plans to
almost double the production. We decided to provide incentives.

CA: Incentives for the workers?

Perez: For the workers. Both for the farmers and for the workers in
the factories. For instance, this year the mechanism is the following:
You have an incentive in dollars, if the farmer surpasses the
program. This year, for instance, 38 percent of the farmers are
receiving incentives.

CA: Is there any chance of getting more involved such as actually
owning farms or doing the farming yourself?

Perez: This is not the target. Our target is to secure that in three
years the production of leaf tobacco and cigars doubles.

CA: So you're hoping that your 27 million cigars in three years
increases to 54 million? You would be very happy! You didn't really
respond to the question of your future with General Cigar.

Perez: Well, the deal is still pending.

CA: I assume that one of the great benefits to General Cigar, and to
you as an owner of General Cigar, is that instead of taking two to
three years to negotiate who owns the Cuban brands, after the embargo
is lifted, you can basically press a button, get two jets and fly them
up and you're in the Cuban cigar business in America before anybody
else. Particularly when it's a brand that they already own, that you
have the worldwide rights to. Right? Like Partagas. You could be
first!

Perez: Yes. If our Cuban friends share this strategy, we could be in a
position to offer our American partner a direct and rapid way of
introducing a brand like Partagas to the U.S..

CA: Besides Partagas, what other brands do you own?

Perez: General Cigar also owns Ramon Allones, Cifuentes and Cohiba for
the U.S. markets.

CA: There is a question with Cohiba. General only owns the name Cohiba
but not the logo art? Who else owns it?

Perez: The Cubans.

CA: This would give General Cigar a huge advantage when the embargo is
lifted, particularly if the embargo isn't lifted for three or four
years, which gives you enough time to build an inventory and warehouse
an inventory so that when it happens, you not only have the legal
issue resolved, you have the inventory in place. What this may mean is
almost withdrawing Partagas from the Spanish market, most of it,
anyway; I mean, if you put away 2 to 3 million each year...

Perez: We could...

CA: The deal is still pending, or let's say the deal doesn't happen,
for whatever reason. When it was announced, it was announced only as
an agreement in principle, subject to further negotiation and
execution of a definitive agreement. But it essentially outlined a
deal of 51 percent ownership for $100 million. What was there--the
brands, the distribution, the personnel at General Cigar--that caused
you to agree to such a significant price?

Perez: It was not only a question of brands. Of course, as you know,
the portfolio of Consolidated is larger than in the case of General
Cigar, because they have Montecristo, and others. No, the elements we
considered very attractive in the case of General Cigar were, first of
all, its position in the market as the leader in the premium segment;
in connection with this, its excellent distribution and promotion
system; and also, leaving aside the premium element, the efficiency in
the machine-made cigars and the efficiency and quality in the handmade
cigars. In analyzing all the aspects of the company, we considered
General Cigar very attractive. At the same time, its size, which is
smaller than Consolidated, was again a positive element for us.

CA: Consolidated was just sold a few years ago. I assume it was sold
before the time that you were actively looking, because had it not
been, you probably would have considered its acquisition as a
possibility. Do you see yourself making further investments in America
to build the General Cigar operation? Will there be other brand
acquisitions?

Perez: Our strategy at present is to be associated with General Cigar;
this is the main target. The 51 percent stake is something. The
principal idea is to get an association between Culbro and Tabacalera
in order to manage General Cigar and to exploit all the potential that
Culbro and Tabacalera can generate together. If this project finally
is successful, I think that we may be limited to further expansion
because of antitrust legislation.

CA: But that doesn't stop you from product-line extensions or new
brands, if you have access to Cuban leaf--to come out with the Pedro
Perez Selection, for instance. You can grow internally, limited only
by your own supply of tobacco. Isn't that right?

Perez: To grow internally is a goal in any company, but as to the
possibility of increasing the size of the project by incorporating
other companies, the problem in my view is a legal one with regards to
the antitrust laws in America.

CA: What are your thoughts about the future of the premium cigar
market, not only in Spain and Cuba, but in the rest of the world?

Perez: I think that the cigar industry is in a great period of
recovery. It is perhaps the only segment in the whole tobacco industry
with such a recovery. This is a fact in the United States; it's also a
fact in Europe. I see a clear future for this particular part of the
industry. Premium handmade cigars are the key to sustaining any
recovery in the tobacco business. More and more people will continue
to discover the pleasure of fine handmade cigars. And once the
consumer is enjoying this product, he or she is going to be tempted to
taste and try not only the handmade cigars but the whole range of
cigar products.